Income definitions for the tapered annual allowance

Transcription

1 ADVISER FACTSHEET Tech Talk March 2016 Income definitions for the tapered annual allowance An introduction to the tapered annual allowance was given in the Aligning pension input periods and the tapered annual allowance Tech Talk issued in August In this Tech Talk we examine in more detail the income definitions used to determine whether tapering of the annual allowance applies to an individual. Contents Introduction Legislation references Threshold income Adjusted income Calculation of A Anti-avoidance Comment For professional advisers only

2 Introduction The tapered annual allowance that comes into effect from 6 April 2016 is targeted at high income individuals. A high income individual is defined by two income measures: Threshold income Adjusted income The logical approach to determine whether or not a person is a high income individual in a tax year is to first calculate their threshold income for that tax year. If their threshold income is 110,000 or less then they are not a high income individual and no further income calculations are required in respect of that tax year. Alternatively, if their threshold income exceeds 110,000 then their adjusted income for the tax year must be calculated to see if their annual allowance in the tax year is subject to tapering. Legislation references ITA 2007 Income Tax Act 2007 FA 2004 Finance Act 2004 ITEPA 2003 Income Tax (Earnings and Pensions) Act 2003 ITTOIA 2005 Income Tax (Trading and Other Income) Act

3 Threshold income Threshold income = A + B C D, where: A. the individual s net income for the tax year (see Step 2 of the calculation in section 23 of ITA 2007) This is essentially the individual s net income for the tax year on which their tax liability is calculated. For some individuals this will involve a relatively straight forward calculation. However, high net worth individuals are likely to have many income sources in which case it would be advisable to enlist the services of the individual s accountant. This is because in order to arrive at A a detailed knowledge of the reliefs due to the individual for the tax year (see sections 24 and 25 of ITA 2007) is required. The Calculation of A heading below gives more detail. B. any amount by which what would otherwise be general earnings or specific employment income of the individual for the year has been reduced by relevant salary sacrifice arrangements or relevant flexible remuneration arrangements which are made on or after 9 July 2015 (and whether before or after the start of the employment concerned) This is an anti-avoidance measure designed to ensure that any reduction in A as a result of a relevant arrangement is added back in. C. the amount (before any deduction under section 192(1) FA 2004) of any contribution paid in the year in respect of which the individual is entitled to be given relief under section 192 (relief at source) Individuals that receive tax relief on their own contributions through relief at source do not see any adjustment in A (contributions are paid net of basic rate tax from their income after tax and an adjustment of their tax bands ensures that any additional tax relief due is forthcoming). Under the net pay arrangement the individual s own contributions are deducted from their income before tax and therefore reduce A. In order to ensure parity the gross amount of the contributions under relief at source is therefore deducted. Contributions that are paid gross by an individual, and tax relief is obtained via a claim, reduce A through one of the reliefs allowed for under section 24 of ITA The way in which tax relief is obtained by the individual on their own contributions will be dictated by the type of pension arrangement e.g. occupational, personal pension, retirement annuity plan. Note that the net pay arrangement is only available through occupational pension schemes. D. the amount of any lump sum which accrues in the year and in relation to which section 579A of ITEPA 2003 is applied by section 636A(4ZA) of the same Act. Where an individual on or after 5 April 2016 is the recipient of a lump sum death benefit from a registered pension scheme and is liable to income tax on the lump sum e.g. because the deceased pension member died after attaining age 75, the amount of the lump sum is deducted as it would have been included in A. 3

4 Adjusted income Adjusted income = A + E + F + G D, where: A and D are as defined for threshold income E. the amount of any relief under section 193(4) or 194(1) FA 2004 Any relief claimed under the sections mentioned above will have been deducted in the calculation of A and there is a requirement for these to be added back in. These reliefs are excess relief claimed under a net pay arrangement and relief on making a claim respectively. F. the amount of any deductions made from employment income of the individual for the year under section 193(2) FA 2004, or under Chapter 2 of Part 5 of ITEPA 2003 in accordance with paragraph 51(2) of Schedule 36 FA 2004 This includes contributions which have been deducted under net pay arrangements reducing A. It also includes deductions in respect of nondomiciled individuals making contributions to overseas pension schemes as these would again reduce A. In both circumstances the contributions/ deductions are added back in. Contributions made under relief at source are not included as these have no impact on the calculation of A. G. the total pension input amount calculated in accordance with section 229(1) FA 2004, less the amount of any contributions paid by or on behalf of the individual during the year under registered pension schemes of which the individual is a member This takes into account any employer funding via a registered pension scheme. 4

5 Calculation of A A is an individual s net income for the tax year calculated under steps 1 and 2 of section 23 of ITA Step 1 is working out total income. This is the total income on which the taxpayer is charged income tax for the tax year. These amounts are calculated in accordance with the rules of ITTOIA 2005 or ITEPA 2003 and are made up of the following components: Employment (including benefits in kind), pension and social security income (ITEPA 2003) Trading and professional income (ITTOIA 2005 part 2) Property income (ITTOIA 2005 part 3) Savings and investment income, including dividends (ITTOIA 2005 part 4) Trade loss relief against general income ((ITA 2007, section 64)* Business losses in early years of trade (ITA 2007, section 72)* Gifts to charities of shares and securities (ITA 2007 sections )) Qualifying contributions to registered occupational pension plans for which relief cannot be given directly from employment earnings e.g. a member of an occupational scheme makes contributions in excess of earnings for that pay period and contributions to retirement annuity plans where the pension provider does not give relief at source (FA 2004 sections 193(4) and 194(1)). These payments are added back when working out adjusted income Other income not covered elsewhere e.g. receipts from intellectual property (ITTOIA 2005 part 5) Step 2 requires that deductions are made for those amounts that tax relief is given by deduction from income to give you net income. The list of reliefs is extensive and is covered under section 24 ITA 2007, but the key tax reliefs given by deduction are: Qualifying interest payments* which include interest on loans for the purpose of: Acquiring a share in a close company (ITA 2007, section 392) Acquiring a share in an employee-controlled company (ITA 2007, section 396) Acquiring an interest in a partnership (ITA 2007, section 398) To purchase plant and machinery (ITA 2007, section 388) Payment of IHT (ITA 2007, section 403) * Qualifying interest and allowable business loss relief claims for anyone wishing to claim more than 50,000 of relief are restricted to 25% of income or 50,000, which ever is the greater. 5

6 EXAMPLE In order to understand how this will work in practice, please consider the following: Gary is an active member of a contributory defined benefit scheme. He is contributing 5% of his pensionable salary to the scheme. The pension he had accrued at the end of 2015/16 tax year was 18,500 p.a. and this had increased to 20,500 p.a. by the end of the 2016/17 tax year. Note that in the 2016/17 tax year the pension input period is aligned with the tax year. Consumer price index (CPI) September 2015 was -0.1%. Pension input amount (PIA) for 2016/17 in respect of the defined benefit scheme: Opening value (OV) = 16 x 18,500 x 1.0 = 296,000 Closing value (CV) = 16 x 20,500 = 328,000 PIA = CV OV = 32,000 Gary s pensionable salary for 2016/17 = 120,000 Gary s member contribution for 2016/17 = 5% of 120,000 = 6,000 Employer contribution for adjusted income = 32,000-6,000 = 26,000 Gary also contributed to a SIPP in the 2016/17 tax year and the table below provides a summary of the information for the tax year: 2016/17 S23 ITA 2007 step 1 & 2 net income 130,000 Member contribution to DB scheme (net pay arrangement) Employer contribution to DB scheme 6,000 (see above) 26,000 (see above) Individual gross contribution to SIPP (relief at source) 8,000 A = 130,000, B = 0, C = 8,000, D = 0 Threshold income = A + B C D = 122,000 (> 110,000) A = 130,000, E = 0, F = 6,000, G = 26,000, D = 0 Adjusted income = A + E + F + G D = 162,000 (> 150,000) Therefore, Gary is subject to a tapered annual allowance of 34,000 for the 2016/17 tax year. His PIA for that tax year is 40,000 ( 32, ,000) and he will be liable for an annual allowance charge unless he has at least 6,000 of unused annual allowance available from the three previous tax years. 6

7 Anti-avoidance There is an anti-avoidance measure in connection with the tapered annual allowance designed to catch a reduction in either or both of the income measures in a tax year and the reduction is redressed with a corresponding increase in another tax year. If caught by this measure the annual allowance for the tax year is calculated based on the income measures before the reduction. Note that this requires self-declaration on the part of the individual concerned. Comment It will be difficult to predict with any certainty what the annual allowance will be in a future tax year for a high income individual. The relevant data is unlikely to be available until sometime after the end of the tax year. This makes tax efficient retirement planning even more difficult. An adviser faced with a client with a history of fluctuating taxable income and non-uniform pension funding is likely to baulk at the task of guiding the client through the retirement planning maze. Throw in some defined benefit pension funding and a daunting task becomes even more so. Carry forward of unused annual allowance from previous tax years is still available. However, if the tapered annual allowance becomes a permanent feature of pension tax legislation the amount of unused annual allowance available will be less and therefore may not be enough to deal with excess pension funding in a tax year. For many high income individuals the completion of their self assessment tax return may reveal an unwanted surprise in the form of an annual allowance charge. The pressure on the Government to protect tax revenues, as well as making pension funding less attractive, is creating an advice challenge that few advisers relish. Let s hope that the outcome of the consultation on pension tax relief delivers relief of a different kind for both advisers and providers. John Dunn Pension Specialist Technical Support Unit Further information Visit the Technical Hub for further information: Neil MacGillivray Head of Technical Support Technical Support Unit Please note that every care has been taken to ensure that the information provided in this article is correct and in accordance with our understanding of current law and HM Revenue & Customs practice. You should note however, that James Hay Partnership cannot take upon itself the role of an individual taxation adviser and independent confirmation should be obtained before acting or refraining from acting upon the information given. The law and HM Revenue & Customs practice are subject to change. The tax treatment depends on the individual circumstances of each client. James Hay Partnership is the trading name of James Hay Insurance Company Limited (JHIC) (registered in Jersey number 77318); IPS Pensions Limited (IPS) (registered in England number ); James Hay Administration Company Limited (JHAC) (registered in England number ); James Hay Pension Trustees Limited (JHPT) (registered in England number ); James Hay Wrap Managers Limited (JHWM) (registered in England number ); James Hay Wrap Nominee Company Limited (JHWNC) (registered in England number ); PAL Trustees Limited (PAL) (registered in England number ); Santhouse Pensioneer Trustee Company Limited (SPTCL) (registered in England number ); Sarum Trustees Limited (SarumTL) (registered in England number ); Sealgrove Trustees Limited (STL) (registered in England number ); The IPS Partnership Plc (IPS Plc) (registered in England number ); Union Pension Trustees Limited (UPT) (registered in England number ) and Union Pensions Trustees (London) Limited (UPTL) (registered in England number ). JHIC has its registered office at 3rd Floor, 37 Esplanade, St Helier, Jersey, JE2 3QA. IPS, JHAC, JHPT, JHWM, JHWNC, SPTCL, SarumTL and IPS Plc have their registered office at Trinity House, Buckingway Business Park, Anderson Road, Swavesey, Cambs CB24 4UQ. PAL, STL, UPT and UPTL have their registered office at Dunn s House, St Paul s Road, Salisbury, SP2 7BF. JHIC is regulated by the Jersey Financial Services Commission and JHAC, JHWM, IPS and IPS Plc are authorised and regulated by the Financial Conduct Authority. The provision of Small Self Administered Schemes (SSAS) and trustee and/or administration services for SSAS are not regulated by the FCA. Therefore, IPS and IPS Plc are not regulated by the FCA in relation to these schemes or services.(01/14) JHSTT 01 FEB16 LD 7